In this study, we explore the effects of a change in unskilled labor in China on the direction of innovation in the US by incorporating production offshoring into a North-South model of directed technical change. We find that intellectual property rights (IPRs) and offshoring are different ways for the labor endowment of the South to affect the size of the market for innovations in the North. Absent offshoring and lacking IPRs in the South - as in China in the early 1980s - an increase in Southern unskilled labor should lead to skill-biased technical change. If instead offshoring is present and/or IPRs are better enforced (as in China in more recent times), then a decrease in unskilled labor in the South should lead to skill-biased technical change. Furthermore, an increase in Southern per capita stock of capital reduces offshoring and also leads to skill-biased technical change. Calibrating the model to China-US data, we find that under a moderate elasticity of substitution between skill-intensive and labor-intensive goods, the decrease in unskilled labor and the increase in capital in China can explain about one-third of the recent increase in the skill premium in China through skill-biased technical change in the US. (C) 2014 Elsevier Inc. All rights reserved.
